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Daily Analysis 8 July 2022 (10-Minute Read)

Hello there,

A fantastic Friday to you as more economic data pours in that suggests inflation may have already peaked in the U.S. while stress on an economic downturn may have eased, buoying stocks and other risk assets alike.

In brief (TL:DR)

  • U.S. stocks surged higher on Thursday with the Dow Jones Industrial Average (+1.12%), S&P 500 (+1.50%) and Nasdaq Composite (+2.28%) all higher as U.S. Federal Reserve officials provided reassuring words that the economy may have evaded a recession.

  • Asian stocks pared initial gains as former Japanese Prime Minister Shinzo Abe was shot and remains unresponsive at time of reporting.

  • Benchmark U.S. 10-year Treasury yields gained to 2.989% (yields rise when bond prices fall) as risk appetite returned and investors poured into equities.

  • The dollar rose in Asian trading.

  • Oil is back over US$100 with August 2022 contracts for WTI Crude Oil (Nymex) (-0.10%) at US$102.63 on optimism over Chinese stimulus and signs that the U.S. economy may have averted a recession.

  • Gold was flat with August 2022 contracts for Gold (Comex) (+0.09%) at US$1,741.20.

  • Bitcoin (+7.57%) gained and was trading at US$21,833, alongside a rise across risk assets, and having gone above US$22,000 momentarily for the first time in weeks.

In today's issue...

  1. U.S. Trade Deficit Narrows in May, Easing Imported Inflation

  2. Hopes of a Broader China Reopening Fade with Vaccine Mandate Walkback

  3. Genesis is Latest Major Cryptocurrency Firm to Admit 3AC Exposure

Market Overview

U.S. equities staged a convincing rally yesterday as U.S. Federal Reserve officials batted down concerns that the economy would inevitably hurtle into a recession because of policy tightening.

Asian equities pared gains as the shooting of former Japanese Prime Minister Shinzo Abe rattled nerves, despite earlier bullishness on the prospect of a massive Chinese fiscal infrastructure stimulus package.

Asian markets were mostly higher on Friday with Tokyo's Nikkei 225 (+0.10%), Seoul's Kospi Index (+0.70%), Sydney’s ASX 200 (+0.45%) and Hong Kong's Hang Seng Index (+0.16%)all up towards the end of the trading session.

1. U.S. Trade Deficit Narrows in May, Easing Imported Inflation

  • Americans are buying less stuff and exporting more energy, narrowing the trade deficit and reducing imported inflation.

  • Softer inflation numbers, provided that they are durable over the next few months, may give the U.S. Federal Reserve the needed cover to soften its hawkishness towards the end of the year.

The U.S. trade deficit narrowed for the second consecutive month in May as imports were curtailed from lower expenditure on goods from American households dovetailed with a spike in energy exports.

The U.S. Commerce Department reported on Thursday that the month of May saw the trade gap in goods and services dip 1.3% from the previous month to US$85.5 billion, a decrease from April’s US$86.7 billion.

In its first decline this year, imports of consumer goods nosedived US$1.5 billion as Americans scaled back demand for goods in favor of services with elevated consumer prices putting a damper on demand.

Retailers continue to carry excess inventory as supply-chain disruptions resulted in misjudged overstocking, reducing demand for fresh imports.

Economists suggest a shrinking trade gap will help improve second quarter economic growth slightly, but the overall impact on the U.S. economy is likely to be minimal as conditions perceptibly slow.

Speaking with Bloomberg, Chief U.S. Economist at Oxford Economics Kathy Bostjancic suggests that “the slower pace of trade flows in categories other than energy” indicate “weaker economic momentum globally.”

And that could turn out to be a silver lining for investors.

With growing signs that the U.S. economy is already in a slowdown, if not recession, and the U.S. Labor Department’s inflation print for June likely to come it lower than in May, the U.S. Federal Reserve may have the necessary cover to dial back its aggressive pace of hikes.

Fewer imports and the imported inflation that comes with it, could help to moderate the pace of price increases, but the Fed will want to see at least several months of inflation starting to trend back to targets before it takes its foot off the gas when it comes to tightening.

If so, the latter half of the year, after the September Fed meeting, may see an early Christmas for risk assets, as policymakers may elect to either slow the pace of rate hikes, or lower each episode, for instance a 25-basis-point increase as opposed to larger 50 or 75-basis point hikes.

2. Hopes of a Broader China Reopening Fade with Vaccine Mandate Walkback

  • Beijing backs down on its vaccine mandate just 48 hours after announcing it, in the face of widespread public condemnation.

  • U-turn on vaccine policy means that China has few easy outs from pandemic-era restrictions and rolling lockdowns, making its 5.5% GDP growth target elusive.

In one of its fastest policy U-turns in recent times, Beijing abruptly reversed its vaccine mandate in a rare concession to criticisms from Chinese citizens.

Less than 48 hours after announcing its first ever vaccine mandate that would require vaccination to enter public venues, instead, Beijing has reverted to its existing zero-Covid strategy.

All public venues are accessible provided that people are able to provide a negative Covid test that’s no older than 72 hours and have their temperature checked.

The abrupt policy backpedaling will deal a major blow to investors hoping that a vaccine mandate could have helped to reopen the Chinese economy and normalize business operations.

Beijing had announced on Wednesday that from July 11, entry to public venues such as cinemas, museums and theaters would be restricted to only vaccinated people, as well as requiring workers in specific sectors to receive booster shots.

But public backlash to the new measures was swift, with some Chinese taking to social media to call the requirement and illegal limitation on their freedom and draw into sharp focus the actual efficacy of Chinse vaccines against the far more virulent omicron variant.

Yet Beijing backing down from the vaccine mandate is a rare display of acquiescence to a population that the Communist Party has immense power over.

Daily movements are already restricted by a complex system of health codes, and hundreds of millions of people are already subject to frequent Covid testing, with cities of tens of millions of people shoved into lockdown on just a handful of cases.

Beijing’s inability to enact a vaccine mandate means that it will continue to be bogged down by economically disastrous zero-Covid lockdown policies of its own manufacture.

China has refused to accept foreign mRNA vaccines which have been proved to be more effective and doubled down on lockdowns and other restrictions to curb outbreaks.

But a seemingly endless cycle of lockdowns and a refusal by the population to vaccinate means that there aren’t any easy or clear paths for China to exit its pandemic footing in the short to medium term, putting further pressure on the economy.

With demand for Chinese imports already slowing in the U.S., with the trade deficit at its lowest level in years, Beijing may need to spend more on infrastructure projects that it doesn’t need to stimulate demand.

And while such misplaced stimulus would provide a momentary boost to the economy, such gains are illusory and lack the durability that stronger domestic consumption could have provided in the absence of rolling lockdowns.

3. Genesis is Latest Major Cryptocurrency Firm to Admit 3AC Exposure

  • Insolvency of cryptocurrency hedge fund Three Arrows Capital is winding its way through the liquidation courts of the British Virgin Islands and forcing more counterparties to come forward with admissions of exposure to the hedge fund.

  • Genesis claims to have mitigated most of its losses from exposure to 3AC, but cross exposure to Babel Finance may make its position more precarious, as evidenced by the need for Genesis parent company Digital Currency Group's intervention to shore up its subsidiary's liability position.

Another major cryptocurrency firm has revealed exposure to the ongoing fallout from the implosion of hedge fund Three Arrows Capital (“3AC”).

One of the largest cryptocurrency brokerages for institutional investors, Genesis, has confirmed that it was exposed to the now-insolvent Three Arrows Capital, but had taken measures to mitigate losses.

In a series of tweets on Wednesday, Genesis CEO Michael Moro said that the firm sold collateral and hedged its downside the minute that 3AC failed to meet a margin call, sharing further that loans to 3AC had a weighted average margin requirement of over 80% without disclosing the full size of loans made to the Singapore-based hedge fund.

Moro added that the parent company of Genesis, Digital Currency Group, assumed some Genesis liabilities to ensure that its subsidiary could continue operating.

The full extent of 3AC’s impact on the cryptocurrency markets is emerging as more crypto lenders and brokerages have begun stepping forward to acknowledge their exposure to the hedge fund’s bad debt.

Digital currency news site CoinDesk reported earlier that Genesis is facing potential losses amounting to “hundreds of millions” of dollars, due to their exposure to 3AC and Babel Finance, a Hong Kong-based crypto lender, which recently froze withdrawals.

It’s believed that Babel Finance may also have had direct exposure to 3AC, although the crypto lender has yet to confirm nor deny such rumors.

As 3AC’s bankruptcy winds its way through the courts in the British Virgin Islands, more counterparties that are exposed to the hedge fund’s collapse will start to come out in the coming weeks and months.

Whereas cryptocurrency-backed loans are typically over-collateralized, it is now becoming apparent that many lenders gave soft loans to 3AC, whether based on the pedigree of their founders and reputations, or because of the promised returns.

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